Knock-on effects

17Jul07

Last week we discussed the potential for credit market stress to spill over into a broader rise in risk aversion. As losses pile-up in the subprime sector there seems to be a reluctance to take risk in other, seemingly unrelated, sectors like buyout-related securities.

These knock-on effects continue to work themselves through the system. While it is unclear what the eventual outcome will be, it is clear that stresses are popping up all across the board. We don’t have any greater insight than that previously mentioned, but here are some additional posts on the topic that help put into some perspective what it happening in the capital markets.

Dennis K. Berman at WSJ.com on the growing tensions between investment banks and private equity funds as the i-banks pull back on their willingness to provide credit for additional deals.

Calculated Risk notes the difficulty investment banks are having in putting together syndicates for already announced buyout deals and the bond ‘inventory overhang’ from already completed deals.

What is going on with ACA Capital Holdings (ACA) stock? Floyd Norris and Vikas Bajaj at NYTimes.com note a sizable drop in the stock as the fears that their subprime-related businesses will take a hit.

Roddy Boyd at the New York Post reports on calls from prime brokers for greater collateral for hedge funds who invest in all manner of mortgage-related securities.

Felix Salmon at Market Movers wonders if fund managers are factoring in ‘illiquidity risk’ into their derivative security pricing models.

Alea highlights a research paper that notes investor preferences for securities with “negatively skewed payoff distributions” like CDOs.

Doug Kass at TheStreet.com on the role leverage has played in previous bubbles and how “…leverage is always the monster that kills, and it will likely have a primary role in upsetting this cycle as it has had historically.

Gwen Robinson at FT Alphaville highlights some contrarian thoughts on the subprime crisis. Could it be that the subprime crisis is good for plain-vanilla Treasury bonds? Both a flight-to-safety and the increased chance of Fed rate cut could lead to lower Treasury yields.

We hope these helped provide some perspective. However, it should be clear that the subprime mortgage mess story is not over, not even by a longshot.